Reforms hold key to Chinese handling of its slowdown

Whither the Chinese economy? It's a question that people are still asking nearly a week after China released first quarter gross domestic product data that was better than feared, but still paints a more downbeat picture of the world's second- biggest economy.

To recap: Gross domestic product growth in China slowed from 7.7 per cent in the final quarter of last year to 7.4 per cent in the first quarter of this one.

This figure was considered better than expected as the median forecast was 7.3 per cent, although the difference between the two is fairly slim, it has to be said.

Pat McCormack, head of the wealth and investment management division of Barclays in Ireland, says slower growth in China may coincide with new opportunities for investors and an improved performance on the stock market. “[In] our view, China has been a fantastic economy but a disappointing investment in recent years and US investors especially would have done far better to stay at home, given the currency differential.”

The key is seeing if the Chinese government sticks to its guns on transforming the economy from an investment to a consumption-driven economy, as outlined at the Third Plenum in November by president Xi Jinping.

“If their financial reforms continue, we might yet see China’s structural slowdown coinciding with improved stock market performance.

“There may be less prospective GDP growth in China, but what there is may be more valuable to investors if more of it makes its way to the corporate bottom line,” said McCormack.

China’s leadership continues to demonstrate its commitment to reform, McCormack argues, and progress in several key areas is now increasingly visible.

While short-term pain may be inevitable, policymakers can and almost certainly will adopt the necessary measures to keep the economy afloat amid the uncertainty of reform.

“In our view, the commitment of China’s leaders to rebalancing the economy and improving the quality and sustainability of growth is positive,” he said.

So far, we have witnessed progress in several key areas including financial reforms; state-owned enterprises (SOEs) reforms; fiscal/administrative reforms; environmental protection; urbanisation and hukou (household registration) reforms; and free-trade
zones.

“China has made some progress with its reforms, but the job is far from finished. Investors may want to see more progress - not just in the areas discussed – but also on such themes as land reforms, tax reforms, and healthcare reforms.

“However, the government will take a measured approach in an effort to balance its commitment to reform with its need to maintain stable growth. Although the task is anything but easy, we remain optimistic that Chinese leaders will be successful in their reform endeavours,” said McCormack.

Some analysts have argued that you could see the figures either positively or negatively and both positions would be plausible, given relief that growth did not slow further.

There is also the argument that the growth figures are less relevant than before, now that the economy has expanded by so much and the base has been raised. Absolute changes in GDP are similar to those seen earlier when growth was in double-digits.

"The economy's performance is the worst since the global financial crisis and a technical recession is possible in the first half of this year," wrote Diana Choyleva at Lombard Street Research.

However, if Beijing remains resolute, it could come through the current storm.

“During 2014 and 2015 a severe economic downturn and financial market distress will test Beijing’s resolve to the limit. If the authorities manage to navigate the storm well and keep their cool, China’s economy has a real chance of emerging from this painful but necessary adjustment in a much stronger position and the rest of the world with it.”